Saudi Arabia’s 2016 Budget Suggests Little Relief In Price Pain

In unveiling its 2016 budget in Riyadh today, the government of Saudi Arabia is sending a broad signal to oil markets and fellow producers alike that it has no immediate plans to change its current oil policy of sustained heightened production, but that it also recognizes the need to rein in spending as the Kingdom anticipates no substantive recovery in oil prices in the coming year. While the 2015 Saudi budget appeared to be based on an overly-optimistic oil price of $80 a barrel, the 2016 budget may be grounded in more realistic terms, apparently predicated on an average oil price of $45 a barrel.

The new budget is the first to be issued under the regime of King Salman Bin Abdul-Aziz, as the Saudi monarch assumed the throne on January 23rd upon the death of King Abdullah Bin Abdul-Aziz. The 2016 Saudi budget forecasts a deficit of $87 billion, with expenditures set at $224 billion and revenue slated at $137 billion. This suggests that the Kingdom is bracing for continued economic upheaval and is trying to stem the fiscal hemorrhaging as it seeks to defend market share and force independent producers to participate fully in balancing oil markets.

The Saudi Finance Ministry announced today that the Gulf producer had recorded a $98 billion budget deficit for 2015, based on spending of $260 billion and revenues of $162 billion. While this is the highest deficit the Kingdom has officially announced, it is lower than what was forecast by analysts and financial institutions, including the International Monetary Fund (IMF), which had suggested that Saudi Arabia’s 2015 budget deficit would likely exceed $106 billion.

Thanks in part to the Saudi-led strategy adopted by the Organization of Petroleum Exporting Countries (OPEC) just over a year ago that was meant to punish independent producers through price pain and help the Kingdom and its Gulf allies recover market share, global oil prices have fallen by as much as 60 percent since mid-2014 to lows not seen in over a decade, and few producers have been spared deep economic pain.

In its 2015 budget announced on December 25, 2014, the Saudi government anticipated a budget deficit of $38.6 billion, predicated on spending of $229.3 billion and earnings of 190.7 billion. However, when that budget was released, the Kingdom had yet to initiate a proxy war with Iran in neighboring Yemen, nor had it been expected that oil prices would fall to the depths they have as demand in key regions has been tepid and oil markets greatly oversupplied. All of these factors have contributed to an economic crisis in the Kingdom, which has compelled the Saudi government to tap into its sizeable financial reserves as well as sell bonds to meet budgetary needs.

The Kingdom has been aggressively dipping into its foreign exchange reserves, which were estimated at $739 billion late in 2014, and have since fallen to $654.5 billion, with the IMF in October cautioning that Saudi Arabia may only have five years left of financial assets if the oil price slump continues and Riyadh maintains its spending habits.

The OPEC heavyweight began issuing public bonds this summer to local banks and institutions as a means to meet budgetary needs. Saudi Arabia is expected to raise some $32 billion in 2016 from selling bonds monthly, adding to the nearly $20 billion it has garnered from debt issuance in 2015.

Not surprisingly, there are indications that the Saudi government has already initiated some economic belt-tightening, including freezing new construction contracts while also delaying payments to some contractors on infrastructure projects for as much as six months and attempting to negotiate lower contract prices.

One area where the Saudi regime is not holding back on spending is in military expenditures, with funds reportedly having been directed from other government sector budgets in 2015 to the Defense Ministry, headed by Deputy Crown Prince Mohammed Bin Salman. While the Kingdom’s defense budget had been growing at a rate of about 14 percent a year over the last decade, it has jumped to a rate of 19 percent a year since 2011, following the Arab Spring. Since then, not only has the Saudi government been contending with domestic Shi’ite dissent but more recently growing attacks being carried out by Islamic State supporters, as well as waging a war in Yemen and participating in air strikes against Islamic State in Syria.

Saudi Arabian defense-related spending is anticipated to rise to about $60 billion a year by 2020 from $49 billion, which will make it the fifth-largest global defense spender. In fact, it appears that the Kingdom is already allocating $56.8 billion to military and security expenditures in 2016.

The Saudi government has indicated that it is ready to take some possibly unpopular steps at home to generate revenues through a new national agenda of reform measures expected to be announced next month, including oil, water and electricity subsidy cuts that will be phased in over five years and a privatization program that will offer up stakes in both state-owned and partly-privatized companies. Deputy Crown Prince Mohammed Bin Salman, who has been granted responsibility over the Kingdom’s economic policies, is believed to be a strong advocate of these reform measures.

Despite intense pressure earlier this month from producers within OPEC with less of the financial cushion that Saudi Arabia, Kuwait, the United Arab Emirates and Qatar have had to withstand the oil price collapse, Riyadh was able to fend off efforts to slash collective OPEC production at the minsterial conference on December 4th in Vienna. Instead, the group opted to continue to produce at full tilt, pumping at roughly 31.5 to 3.2 million b/d, with the looming threat of Iran bumping up its output in 2016 and adding extra barrels into a saturated oil market as U.N. sanctions on the Gulf producer are gradually eased.

Although Iranian officials have claimed that the OPEC country could boost exports by 500,000 b/d within a week of sanctions being lifted and increase exports by another 500,000 b/d in the following six months, this declaration is thought to be overly ambitious given the inherent challenges of restarting aging oilfields. That’s not to say that Iran won’t push out large volumes initially, but if so it’s likely originating from storage. Saudi Arabia will be watching how much oil actually gets exported from Iran in the coming months before it even considers shifting its current production strategy and welcomes a collective reduction within OPEC as well as demanding cuts from non-OPEC producers.